Unintended Consequence of New Tax Law

New Tax Law Could Give Cooperatives Advantage Over Private Grain Companies

A provision in the new tax law could end up causing farmers to deliver their grain and other commodities largely to cooperatives at the expense of private grain companies. (DTN file photo)

NASHVILLE, Tenn. (DTN) -- The law of unintended consequences has followed close on the heels of the new tax law, and it is coming down on private grain companies.

Language added to the tax law in December to help boost farmer cooperatives could end up causing famers to deliver their grain and other commodities largely to cooperatives, at the expense of private grain companies, in order to get a larger deduction on their income.

Staff at Iowa State University's Center for Agricultural Law and Taxation said they have been getting flooded with emails over the past week about the treatment and effects of qualified cooperative dividends. In a column, Kristine Tidgren, assistant director of the center, said the new provision will affect farmers who market commodities through cooperatives in which they are a member versus selling commodities to non-cooperatives.

The provision in the law allows farmers to take advantage of the new 20% deduction on all qualified business income, like every other smaller business. But on top of that, farmers can deduct, "up to the amount of their taxable income (not including capital gain income) an amount equal to 20% of their 'qualified cooperative dividends.'"

In another note, the way the language is written in the law, this extra tax deduction only applies to agricultural cooperatives.

The deduction for qualified cooperative dividends allows a taxpayer to deduct the lesser of "20% of the aggregate amount of the qualified cooperative dividends of the taxpayer for the taxable year, or, taxable income minus net capital gain."

In drawing a comparison about the differences between having the cooperative deduction and not having the cooperative deduction, Iowa State compared scenarios of a farmer who had $300,000 in grain sales and $180,000 in expenses, leading to net Schedule F income of $120,000. With the regular Section 199A deduction, the farmer's taxable income for the year is $86,400. Applying the cooperative benefit, taxable income drops to $48,000.

"A plain reading of the text of the new law would suggest that it potentially provides a significantly larger Section 199A deduction to some member farmers marketing their products through a cooperative than to farmers selling to a non-cooperative. But it is too early to tell if this interpretation will be implemented," Tidgren wrote.

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As Paul Neiffer, a principal at CliftonLarsonAllen explained, to receive the qualified cooperative dividend deduction, a farmer must be a patron of the cooperative and sell his or her grain there.

As Neiffer explains, a simple way to look at it is for a farmer to take their tax bracket and multiply it by 0.20. If a farmer is in the 35% tax bracket, that comes to 7% savings.

"It is a clear potential advantage," Neiffer said. "I always want to highlight the word 'potential' because the key is they have got to have taxable income. If they don't have taxable income, this deduction is worth absolutely nothing."

Another question, Neiffer and Tidgren pointed out, is some of the benefits could change depending on how the IRS offers guidance or a rule on how taxpayers should treat the provision.

Another accountant who spoke to DTN on background said the provision could cause private grain companies to create separate cooperatives for grain delivery. Ethanol plants could also end up getting grain from cooperatives rather than buying more direct from farmers. It was suggested cooperatives could end up building more storage to hold more grain. However, the benefits of this tax provision right now are scheduled to sunset in 2025. "Who wants to make a major investment in infrastructure for a temporary tax benefit?" the accountant said.

If a farmer is not a cooperative patron and selling to the cooperative, he or she will still likely qualify for the regular Section 199A deduction of 20% of net farm income.

The scenarios being run on these tax savings come without any IRS rules. Once those are written, proposed and finalized, the situation and overall benefit could change.

The qualified cooperative dividend was added late to the tax bill by Sen. John Hoeven, R-N.D., and Sen. John Thune, R-S.D., who were trying to stave off a large tax increase for farmers who had relied on the prior Section 199 Domestic Production Activities Deduction. The National Council of Farmer Cooperatives had pushed for a change, arguing farmers who sell to cooperatives risked a $2 billion annual tax break if it went away and was not replaced with similar language. Chuck Conner, president and CEO of National Council of Farmer Cooperatives, warned against making changes to the new tax break that could end up raising taxes on farmers.

"Section 199A was included in the tax reform package because Congress realized that eliminating the Domestic Production Activities Deduction, also known as DPAD, without these provisions would have resulted in a tax increase on farmers across the country," Conner said. "NCFC and our members supported retaining DPAD, with its track record of promoting growth in rural America, for agriculture; policy makers ultimately decided that they preferred to replace it with a deduction that fit under the new structures they created in the tax bill. It should also be noted that Section 199A sunsets in 2025 while other provisions for non-cooperative business, such as a 40% cut in the corporate tax rate from 35% to 21%, are permanent.

"Looking forward, we believe that Congress should avoid any action that would raise taxes on farmers, especially at a time of continued low commodity prices," Conner said.

The National Grain and Feed Association, which represents both private grain companies and cooperative firms in Washington, declined a request to comment on the tax provision.

Leaders from the American Farm Bureau Federation told DTN this week they had just learned about the implications of the tax change and would review the issue more when leadership returns to Washington from the group's annual meeting in Nashville.

Kami Capener, a spokeswoman for Sen. Hoeven, told DTN that the goal was to prevent cooperatives from being "unfairly treated" by the loss of the domestic-production deduction. "We are continuing to work with Sen. Thune and stakeholders to address any unintended impacts," she said.

The problem with making a technical correction to the tax law is it now would require 60 votes in the Senate to make a change in the law. Much like Republicans refused to help Democrats make changes to the Affordable Care Act, Democrats may be unwilling to help Republicans make similar changes in the new tax law.

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